The unprecedented collapse of the We Company, which went from a $47 billion debutante to the brink of failure in just a few short weeks, marked a turning point in the stock market.
Investors have since become warier of several other recent IPO's, sending stock prices for a number of them, including Uber (UBER +2.41%) and Lyft, plunging. The market has become skeptical of high-priced tech stocks, especially cloud computing companies, and have also bailed on money-losing stocks that show little sign of turning a profit.
The unraveling of the WeWork parent could signal a reckoning in another industry: food delivery services. Though the companies that hustle dinner to your door may seem to have little in common with the office-sharing real estate juggernaut, both WeWork and the food delivery boom were fueled by a tidal wave of venture capital and have little in the way of barriers to entry that would allow any given company to establish a sustainable competitive advantage. Let's take a closer look.
Image source: Getty Images.
The Softbank effect
WeWork's sudden rise would not have been possible without Softbank (SFTBY +4.08%), the Japanese tech conglomerate turned venture capital firm. Led by CEO Masayoshi Son, Softbank has plowed $10.4 billion into the now-troubled office-sharing start-up, allowing it to expand around in the world and populate global capitals like New York and London with dozens of office locations, making the company by far the best-known brand in its industry.
Softbank didn't begin investing in the We Company until 2017, but it was largely responsible for lifting WeWork's valuation from $21 billion in August 2017 to $47 billion this January.
Following the withdrawal of the We Company's IPO, Softbank has been left with potential losses in the billions; it must feed more cash into the We Company to keep it afloat, as We had been counting on funding from the IPO to fuel its cash-burning expansion. Softbank, which owns about 29% of the WeWork parent, is in talks to loan $5 billion in rescue financing to the coworking specialist, which could run out of cash as soon as next month.
The Japanese company has become the world's most prolific venture capitalist, and while the WeWork collapse is the company's highest-profile miss so far, this is not the only time Softbank has inflated the valuation of a fast-growing start-up.
The food delivery connection
Like the We Company, Uber strutted into its IPO with significant backing from Softbank, Uber's biggest shareholder. The Japanese company has poured about $8 billion into Uber, coming in at the end of 2017 to pump up the ride-sharing giant's valuation after cofounder Travis Kalanick was forced out of the CEO chair following a series of scandals.
Softbank's cash helped fuel Uber's growth and the expansion of its Uber Eats food delivery service, which rapidly gained share in 2018, but Uber is also bleeding cash, set to lose more than $3 billion in adjusted EBITDA this year. Since its IPO in May, Uber's valuation has gotten a dose of reality in the form of its stock price falling by nearly a third. As a result, Softbank has lost more than $600 million on its investments in Uber.
However, Uber did not represent Softbank's only investment in a food delivery app. It also invested hundreds of millions of dollars into DoorDash, now the food delivery market share leader in the U.S. and valued at $12.6 billion. Softbank's decision to plow money into both Uber and DoorDash is puzzling, as the two companies are competing against one another in a brutal battle over market share, essentially spending Softbank's cash on advertising and customer acquisition.
More importantly, the way Softbank has propped up both Uber and DoorDash seems to signal that the industry is overvalued, thanks to easy money from the Japanese financier. As it did with WeWork, the market will eventually catch up with the reality in the industry.
Where the delivery battle is going
Profits are getting harder to come by in the food delivery industry. The chart below shows what's happened to profit margins at Grubhub (GRUB +0.00%), the only pure-play food delivery stock on the market.
GRUB Profit Margin (TTM) data by YCharts
As you can see, the Seamless parent's profitability was relatively steady for much of its history, above 8%, but that figure has plunged in recent quarters, mostly because of competition. Through the first half of this year, Grubhub's sales and marketing expenses have jumped 61%, compared to just 37% growth in revenue, a sign that it's getting more expensive for the company to find new customers and keep the ones it has, thanks in part to the billions that Softbank has thrown at Uber and DoorDash. CEO Matt Maloney told The Wall Street Journal, "We see a lot of activity that's being funded by late-stage [venture capital] money," hinting that such competition is not sustainable.
Grubhub is profitable, targeting adjusted EBITDA of $235 million to $250 million this year, but competitive dynamics in the industry are likely to continue to push down profitability. Not only are the major players, including Postmates, spending aggressively on advertising, but restaurants are beginning to push back on delivery apps, frustrated with the charges that cut into their margins.
A number of restaurants have canceled exclusive partnerships with individual delivery apps, robbing them of one of the few ways they have of distinguishing themselves from one another. For example, McDonald's ended its exclusive relationship with Uber this summer, adding DoorDash as a partner and later Grubhub in New York.
The industry dynamics also look bad enough that Amazon gave up on food delivery in June, shuttering Amazon Restaurants, and Postmates also said it would delay the IPO it announced back in February, a sign that investor enthusiasm for the sector may be waning in the aftermath of the WeWork debacle.
While app-based food delivery has been popular with customers as well as restaurants in need of a boost like Chipotle, for investors it is beginning to look like a minefield. The WeWork saga shows how funneling billions of dollars into an unprofitable start-up can lead to inflated valuations and unsustainable business models that blow up on investors.
The billions that Softbank poured into Uber and DoorDash seem to be having a similar effect in food delivery. Both Uber and Grubhub stocks have plunged this year, and Grubhub's profitability is quickly evaporating.
Considering that Uber and DoorDash still have plenty of cash to spend in this market share battle royale, the fallout from billions in funding in the food delivery industry seems far from over.
